Transcript Document

6
Money
Markets
Money Market Securities
 Individuals/businesses/govts may have excess
funds to invest but only for a short-period of time
 WWU temporarily invests its building funds.
 Wal-Mart temporarily has excess operating cash
 At the same time, some may need to borrow
funds for the short-term
 Seasonal cash demands for inventory, payroll,
temporary operating cycle shortages, etc.
 Factors for short-term investments
 Maturity, Liquidity, Price Stability, Security
 A return greater than your ordinary bank savings
account
Money Market Securities (cont.)
Money Market Securities (MMS) are debt (lending)
securities with original maturities of one year or less.
Examples:
1.
2.
3.
4.
5.
6.
Treasury Bills
Commercial paper
Negotiable certificates of deposits
Repurchase agreements
Federal funds
Banker’s acceptances
1. Treasury Bills
 Issued to meet the short-term needs
of the U.S. government (i.e. the Federal debt)
 Sold at a discount and mature at par value
 Advantages
 No default risk—backed by the Federal government
 No liquidity risk --- excellent liquidity for investors
 Short-term maturity (4, 13, 26 or 52 weeks)
 Very good secondary market
 Come in multiples of $1,000
 When economic downturns come, a “flight to safety” makes
T-bills attractive.. In Dec/08, investors were so desperate to
park their funds in T-bills for safety they were willing to
accept a zero or slightly negative interest rate
 Disadvantages: low return
Neg.!
Treasury Bills (cont.)
Noncompetitive Bidding
 Treasury determines total amount needed to
borrow.
 Treasury first accepts noncompetitive bids up to
maximum of $5 million face value (see
www.treasurydirect.gov )
 May be used to make sure bid is accepted
 Investors do not know the price in advance so they
submit funds for full par value
 After the auction, investor receives refund for the
difference between par and actual price
Treasury Bills (cont.)
Competitive bidding
 Used by large investors because of $5m limit
 Bids submitted to Treasury by the deadline
 Treasury accepts highest bids until desired borrowed amount has
been reached.
 Price paid to non-competitive bidders is the lowest accepted
competitive bids.
 Very liquid secondary market assures investors that they
can sell their investments before maturity if necessary.
 For auction schedule, see
http://www.treasurydirect.gov/RI/OFAnnce
Treasury Bills (cont.)
See auction calendar at http://www.treasury.gov/resource-center/data-chart-center/quarterlyrefunding/Documents/auctions.pdf
Treasury Bills (cont.)
Pricing Treasury Bills
a.
Priced at a discount from their par value
b. Price depends on the investor’s required rate of return
c.
Value of a T-bill is the present value of the par value
Example: If investors require a 7 percent annualized return on a
one-year T-bill with a $10,000 par value, the price that they are
willing to pay is:
P = $10,000 / (1.07)
P = $9,345.79
Treasury Bills (cont.)
Calculating T-Bill Annualized Yield
YT =
SP – PP
PP

365
n
YT = The annualized yield from investing in a T-bill
SP = Selling price (or par value if held to maturity)
PP = Purchase price
n = number of days of the investment (holding period)
Treasury Bills (cont.)
T-bill discount for a newly issued security
T-bill discount =
Par – PP
Par

360
n
T-bill discount = percent discount of the purchase price from par
Par = Face value of the T-bills at maturity
PP = Purchase price
n = number of days to maturity
Commercial Paper
 S/T loans to large banks or corporations who have established solid
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credit records for operating or S/T needs only (not for fixed asset or L/T
needs)
Borrowers are financial institutions (banks, finance co.) or non-financial
organizations (Boeing, LLU, Wal-Mart, Hershey’s, etc.)
Financial institutions often use CP to fund the credit cards they offer and
other S/T cash needs.
Non-financial business use CP to fund seasonal inventory and other S/T
cash needs (retailers at Christmas; candy co. at Halloween or Easter,
etc.)
Alternative to bank loan (usually cheaper than bank loan), although some
bank loans are still used to maintain relationship with bank.
Usually unsecured (no collateral) but often backed by bank lines of credit
Default risk exists (Penn Central, Wang Labs, Lomas Financial, Drexel
Burnham Lambert) so CP is rated by agencies (S&P, Moody’s, Fitch’s)
Maturities run from 1 to 270 days (usually about month). Why? Because
SEC required all paper exceeding 270 days to be registered.
Minimum is $100,000 but usually sold in millions
Not an active secondary market (liquidity risk)
Commercial Paper (cont.)
 Dealers can place CP but expensive to pay .05% commissions
 If a firm issues a lot of CP, the firm can directly place it
with investors (e.g Ford Motor Credit).
Bruce Bent
 With the failure of Lehman Bros. in Sept/08, the CP market came to
an abrupt halt and rates spiked to levels unseen before. The funds
that greased the wheels of commerce seized up. This situation is
what scared Hank Paulson (U.S. Treasury Secr.) to first ask for a
Federal bailout.
 Lehman’s Bros. collapsed on 9/15/08. Many MMMFds held
Lehman’s CP. The next day, Reserve Primary Fund (the oldest and
one of the largest MMMF) had to write off $785m of LB CP, which
caused it to break the buck (97 cents on the dollar). Breaking the
buck means that the value of the fund per share dropped below
$1.00. Other than a minor incident in 1994, this was the first time in
history that MMMFd broke the buck.
 Bruce Bent started the first MMMFd with his Reserve Primary Fund in
1971. On 9/15/08, 54% of the assets were in CP. Bent, 71-yearsold, was vacationing in Europe, but had to cut his vacation short.
Commercial Paper (cont.)
To stabilize the money
markets, the Fed began
purchasing CP on Oct.
26, 2008. As can be
seen on the graph, CP
rates declined
substantially as the
Fed’s actions brought
liquidity and confidence
back to the CP market.
CP Rates After Lehman Collapse
Commercial Paper (cont.)
Estimating commercial paper yields
YCP =
Par – PP
PP

360
n
YCP = Commercial paper yield
Par = Face value at maturity
PP = Purchase price
n = number of days to maturity
Negotiable Certificates of Deposit (NCD)
 Issued by large commercial banks
 Minimum denomination of $100,000 but $1 million more
common (no deposit insurance if over $250k at same
bank)
 Purchased by nonfinancial corporations or money
market mutual funds
 Good secondary markets supported by dealers
 Can be placed directly or thru dealers.
 Offers rate higher than T-Bill because more liquidity and
default risk.
SP  PP  interest
 Yield:
YNCD 
PP
Repurchase Agreements (Repos)
 Borrower sells a security to investor with the agreement to
repurchase it at a specified date and price
 For example, Baker Boyer Bank sells a repo to WWU & will
pay back the money plus a fee (interest) in two weeks.
 Flexible maturity– 1 day to 1 year, often overnight or over
weekend, with 1-15 days & 3 or 6 months most common
 Backed by collateral (usually Treasury Securities) so if
borrower defaults lender gets collateral (no default risk)
 Usually minimum of $10m but can be much smaller
 Dealers and brokers used or direct placement
 No secondary market (some liquidity risk)
 Reverse repo: buyer is lender, purchase with agreement to
sell
Repos (cont.)
Estimating repurchase agreement yields
Repo Rate =
SP – PP
PP

360
n
Repo Rate = Yield on the repurchase agreement
SP = Selling price
PP = Purchase price
n = number of days to maturity
Federal Funds
 Interbank lending and borrowing, often for reserve requirements,
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with common maturity 1-7 days
Federal funds rate usually slightly higher than T-bill rate because of
slight default risk
Fed District Bank debits and credits accounts for purchase
(borrowing) and sale (lending)
Federal funds brokers may match up buyers and sellers using
telecommunications network
Usually $5 million or more
Bankers Acceptances
 Exporters want payment assurance before sending to a
foreign destination AND importers can receive goods
without giving immediate payment because of bank
guarantee
 Bank stamps a time draft from the importer ACCEPTED
and guarantees to make good on the payment at a
specific time
 Exporter can hold BA or sell before maturity at a
discount (so no liquidity risk)
 Maturities are usually 30-270 days
 Banks may possibly default so a little bit of default risk
Exhibit 6.5
Purchase Order
5
Shipment of Goods
3
American Bank
(Importer’s Bank)
Shipping Documents & Time Draft
2
L/C Notification
Exporter
L/C (Letter of Credit) Application
Importer
1
4
6
L/C
7 Shipping Documents & Time Draft
Draft Accepted (B/ACreated)
Japanese Bank
(Exporter’s Bank)
Summary of Money Market Instruments
Money Market Yields over Time
(Annualized Yields, One-Month Maturity)
International Rate Comparison
Rates tend to be correlated over time. Flow of money between
countries has increased, due to tax differences, anticipated
exchange rate movements, and fewer gov’t barriers
Globalization of Money Markets
 Eurodollar deposits and Euronotes
 Dollar deposits in banks outside the U.S. (even
Canada!)
 BTW: It is estimated that about $1T exists in U.S.
currency and coin, most of which is held outside the
U.S.
 Eurodollars have increased because of international
trade growth and U.S. trade deficits over time
 No reserve requirements at banks outside U.S.
 Eurodollar Loans
 Channel funds to other multinationals that need shortterm financing
Globalization of Money Markets
 Euro-commercial paper
 Issued without the backing of a banking syndicate
 Maturity tailored to investors
 Dealers that place paper create a secondary market
 Rates usually range between 50 and 100 basis points above the
LIBOR rate